Washington Bond traders are starting to price in the prospect of the United States government skipping repayments on its debts, as the October 17 debt ceiling deadline approaches.

There has been a big spike in the interest rates on short-term US Treasury bills due to be paid in the next few weeks.

The US Treasury sold $US30 billion of one-month bills on Tuesday at an interest rate of 0.35 per cent, the highest since the 2008 financial crisis.

The yield on a three-month zero-coupon Treasury bill due October 31 has jumped from an effective rate of zero to 0.27 of a percentage point over the past three weeks.

“That’s a very, very big increase in yields for an instrument that has just a few weeks left to maturity," said Macquarie Group’s New-York based global interest rates and currencies strategist, Thierry Wizman.

“Investors are concerned there may be a principal payment skipped."

Some banks are no longer accepting short-term Treasury bills as collateral in counter party transactions, which is forcing the owners to sell into the market and driving down the price and increasing the yield.

Bond prices and yields are inversely related. The Dow Jones Industrial Average fell 1.07 per cent on Tuesday and the S&P 500 Index dropped 1.23 per cent.

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Flight to long-term securities

As the US Congress flirts with failing to lift the $US16.7 trillion borrowing limit before Thursday next week, there has paradoxically been stronger demand for long-term US Treasury government bonds.

The yield on the 10-year Treasury yield is anchored at 2.63 per cent, down from 3 per cent last month when traders were factoring in the US Federal Reserve to begin tapering its $US85 billion monthly bond buying program.

“There definitely has been a flight to quality out of equities and into ostensibly safer Treasuries but most of that move has been at the long end of the curve." Mr Wizman said.

“When there is a flight to quality, investors typically fly into the long end of the curve, not the short end."

If the impasse runs close to the October 17 deadline, the interest rate on the 10-year Treasury could fall to about 2.4 per cent, he said.

During the October 2011 debt ceiling standoff, investors sold equities and piled into 10-year Treasuries due to their perceived safety.

The US government has a $US6 billion interest payment due on October 31. Several subsequent multi-billion dollar repayments are due in November.

All options being explored: Obama

Treasury estimates that no later than October 17, the US government will have $US30 billion on hand, below net daily expenditures of as high as $US60 billion which go towards repaying borrowings.

Treasury Secretary Jack Lew has previously dismissed the idea of prioritising payments to bond holders if the borrowing limit is not raised. Mr Obama said on Tuesday the government was exploring all contingency options. However, he warned any such move would be at the expense of welfare recipients, government employees and businesses contracting to the government.

Chris Krueger, analyst at Guggenheim Partners estimated that there was a 40 per cent chance that Washington fails to raise the debt ceiling by October 17. “October has relatively light outflows, but November 1 is a huge date for entitlement benefit payments and interest on the debt, so it seems highly unlikely that even if the Treasury limped through post-October 17th, they could not continue into November," Mr Krueger said.

Economists at Goldman Sachs noted that if payments can be prioritised, government spending would fall by between $US75 billion and $US175 billion in November

“It is clear that a pullback of the magnitude we estimate could result in a meaningfully negative effect on economic activity if not addressed quickly," Goldman said in a note to clients.